Todd Harrison: Is a Currency Crisis Knocking at the Door?

Global central banks begin a familiar dance.

Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.

There has been a lot of discussion lately about the emerging markets and the specter of contagion. When the S&P 500 (INDEXSP:.INX) drops 70 handles in five sessions, folks look to assign reason for the rhyme -- which is entirely different than whether or not there's something to it.

It's been seven years since we penned The Credit Card. I'm reminded of that column as we pieced together a series of events to form a mosaic of the financial dynamic as central and commercial banks responded to the "contained" sub-prime housing mess. We were early in our observations, but there was clear benefit in examining the "why" rather than simply accepting the "what."

Fast-forward to today's environment; following a powerful and persistent multi-year stock market rally, the collective perception surrounding a downside catalyst has been marginalized, if only because there have been so many false alarms. We touched on the complacency last week, including the depressed levels of volatility, and while the seed of fear has been planted (the VXO (INDEXCBOE:VXO) is up 50%), the process of price discovery continues.

To be sure, the next iteration of the financial crisis need not look like the last; it rarely does. Over the course of my 23-year career, I've traded through the Orange County crisis, an Asian Contagion, Y2K, the tech bubble and crash, the housing crisis, the banking crisis, and various peripheral events. While they were each unique in cause and effect, they shared common characteristics, including the psychological continuum of denial, migration, and panic.

Perhaps it's a stretch to read into the outsized rate hike in Turkey or the unexpected tag-along in South Africa; truth be told, it's too early to tell.

What I will say is that the market has enjoyed one of the strongest rallies in history, and very few people feel like we're at all-time highs, which is also reminiscent of last decade's pre-crisis environment. This, of course, begs the obvious if not scary question: If folks are freaking out after a 4% pullback, what awaits when a more meaningful downside ride perpetuates a negative wealth effect?

We have witnessed an insane amount of synthetic engineering, not just by financial institutions, but at the Federal Reserve, Bank of Japan, and ECB. My primary concern is that the unintended consequences of those actions will manifest into unforeseen catalysts, be it the continued devolution of social mood or something entirely more structural.

To borrow a quote from 2009, "As governments take on more risk -- as they price assets on behalf of the market and transfer debt from private to public -- the common denominator, or release valve, becomes the currency...and if we inject drugs that mask the symptoms rather than medicine to cure the underlying disease, the likelihood of a seismic readjustment increases in kind."

I'm not smart enough to know whether we're at the beginning that process or if this is yet another false alarm, but as always, we would be wise to see both sides -- particularly when so few people are.